The financial sector including the banking sector, equity markets, external commercial borrowings and remittances has

not remained unscathed though fortunately, the Indian banking sector was not overly exposed to the sub-prime crisis. Only one of the larger banks, ICICI, was partly affected but managed to thwart a crisis because of its strong balance sheet and timely action by the government, which virtually guaranteed its deposits. The equity markets have seen a near 60 percent decline in the index and a wiping off of about USD1.3 trillion in market capitalization since January 2008 when the Sensex had peaked at about 21,000. This is primarily due to the withdrawal of about USD12 billion from the market by foreign portfolio investors between September and December 2008. The foreign investors withdrew these funds in order to strengthen the balance sheet of their parent companies. Commercial credit, both for trade finance and medium-term advances from foreign banks has virtually dried-up. This has had to be replaced with credit lines from domestic banks but at higher interest costs and has caused the Rupee to depreciate raising the cost of existing foreign loans. Finally, while the latest numbers are not yet available, remittances from overseas Indians have reportedly fallen as oil producing economies in the Gulf and West Asia begin to suffer from decline in oil prices.

How has India been hit by the crisis?

The contagion of the crisis has spread to India through all the channels the financial channel, the real channel, and importantly, the confidence channel. Let us first look at the financial channel. Indias financial markets equity markets, money markets, forex markets and credit markets had all come under pressure from a number of directions. Indian equity market will continue to track global developments in 2009. First, the Indian stock markets, both BSE as well as NSE, fell dramatically over 2008 Indias main index sensex plunged nearly 50% during the year from a high of 19,080 in January 2008 to 8,674 in January 2009. The NSE also fell by a similar percentage. Foreign institutional investors pulled out close to Rs 50,000 crore (Rs 500 billion) from the domestic stock market in 2008-09, almost equalling the inflow in the previous fiscal. As per the latest information on the Securities and Exchange Board of India website, FIIs net outflows have been Rs 47,706 crore (Rs 477.06 billion) till March 30 in the financial year 2008-09 as against huge inflows of Rs 53,000 crore (Rs 530 billion) in the previous fiscal. However, it is believed that FIIs may resume investments in Indian equities later in FY 2009-10, as the country still remains an attractive investment destination with sound

fundamentals. As a consequence of the global liquidity squeeze, Indian banks and corporates found their overseas financing drying up, forcing corporates to shift their credit demand to the domestic banking sector. Also, in their frantic search for substitute financing, corporates withdrew their investments from domestic money market mutual funds putting redemption pressure on the mutual funds and down the line on Non-Banking Financial Companies (NBFCs) where the MFs had invested a significant portion of their funds. This substitution of overseas financing by domestic financing brought both money markets and credit markets under pressure. In the foreign exchange market, although there has been some flight of foreign capital from the Indian capital markets, the current level of reserves is reasonably healthy. In fact, the extent of inward remittances during 2008 was a record $40 billion. The forex market came under pressure because of reversal of capital flows as part of the global deleveraging process. Simultaneously, corporates were converting the funds raised locally into foreign currency to meet their external obligations. Both these factors put downward pressure on the rupee. Third, the Reserve Banks intervention in

the forex market to manage the volatility in the rupee further added to liquidity tightening. On the real channel, the transmission of the global cues to the domestic economy has been quite straight forward through the slump in demand for exports. The United States, European Union and the Middle East, which account for three quarters of Indias goods and services trade are in a synchronized down turn. Service export growth is also likely to slow in the near term as the recession deepens and financial services firms traditionally large users of outsourcing services are restructured. Remittances from migrant workers too are likely to slow as the Middle East adjusts to lower crude prices and advanced economies go into a recession. Beyond the financial and real channels of transmission as above, the crisis also spread through the confidence channel. In sharp contrast to global financial markets, which went into a seizure on account of a crisis of confidence, Indian financial markets continued to function in an orderly manner. Nevertheless, the tightened global liquidity situation in the period immediately following the Lehman failure in mid-September 2008, coming as it did on top of a turn in the credit cycle, increased the risk aversion of the financial system and made banks cautious about

lending. The purport of the above explanation is to show how, despite not being part of the global financial sector problem, India has been affected by the crisis through the pernicious feedback loops between external shocks and domestic vulnerabilities by way of the financial, real and confidence channels.
The economic slowdown of the advanced countries which started around mid 2007, as a result of sub-prime crisis in USA and within no time engulfed the whole world and has affected each and every individual across the globe. World over, companies are biting dust including lions of financial world like, Lehman Brothers, Bear Sterns, AIG, Merill Lynch etc. Many banks are almost on the verge of collapse and frantic steps are undertaken by the respective governments to prop them up. The contagion has traversed from the financial to the real sector and the recession will be deeper and the recovery appears to be longer than earlier anticipated. Many economists are now predicting that this Great Recession of 2008-09 will be the worst global recession since the 1930s. A recession is a decline in a country's Gross Domestic Product (GDP) growth for two or more consecutive quarters of a year. A recession normally takes place when consumers lose confidence in the growth of the economy and spend less. This leads to a decreased demand for goods and services, which in turn leads to a decrease in production, lay-offs and a sharp rise in unemployment. Investors spend less as they fear stocks values will fall and thus stock markets fall on negative sentiment. Impact on Indian Economy: The impact of the crisis is deeper than estimated by our policy makers although it is less severe than in other emerging market economies. Further, the Indian banking system is one of the least affected in the whole world and has been praised by many of the economists and financial experts. The banks were saved from this downturn because of the financial policies which were very well formulated that acted as an insulator for the Indian banks. The extent of impact has been restricted due to several reasons such as-

Indian financial sector particularly our banks have no direct exposure to tainted assets and its off-balance sheet activities have been limited. The credit derivatives market is in nascent stage and there are restrictions on investments by residents in such products issued abroad.

Indias growth process has been largely Domestic Demand Driven and its reliance on foreign savings has remained around 1.5 per cent in recent period.

Indias comfortable Foreign Exchange Reserves provide confidence in our ability to manage our balance of payments notwithstanding lower export demand and dampened capital flows.

Rural demand continues to be robust due to mandated agricultural lending and social safety & Rural Employment Generated programs.

Indias Merchandise Exports are around 15 per cent of GDP, which is relatively modest.

Despite these mitigating factors, India too has to weather the negative impact of the crisis due to rising two-way trade in goods and services and financial integration with the rest of the world. Indian economy is experiencing the following incidental effects of the Global Crisis.

Slowing Gross Domestic Product: In the past 5 years, the economy has grown at an average rate of 8-9 per cent. Services which contribute more than half of GDP have grown fastest along with manufacturing which has also done well. But this impressive run of GDP ended in the first quarter of 2008 and is gradually reduced and now it is projected at 6 per cent for 2009-10. Hence, the slowdown in Indian economy is evident from the low GDP growth with deceleration in the industrial activity, particularly in the manufacturing and infrastructure sectors and moderation in the services sector mainly in the construction, transport and communication, trade, hotels and restaurants.

Reduction in Employment: The recession is likely to have a dual impact on the outsourcing industry. Appreciating rupee along with poor performance of US companies will affect the bottom line of the BPOs, which are operating at a net margin of 7-8 per cent, will find it difficult to survive.

Taxation: The economic slowdown has severely dented the Centers tax collections with indirect taxes bearing the brunt. The tax-GDP ratio registered a steady increase from 8.97 per cent to 12.56 per cent between 2000-01 and 2007-08. But this trend has been reversed as the tax-GDP ratio has fallen to 10.95 per cent during current fiscal year mainly on account of reduction in Customs and Excise Tax due to effect of economic slowdown.

Reduction in Exports: The growth in exports was robust till August 2008, however, export growth evinced a sharp dip and remained negative till the end of the financial year on account of major outsourcing deals with US companies, which were effected in the crisis.

Forex Market: The current economic crisis was largely insulated by the reversal of foreign institutional investment (FII), external commercial borrowings (ECB) and trade credit. Its spillovers became visible in September-October 2008 with overseas investors pulling out a record USD 13.3 billion and fall in the nominal value of the rupee from Rs.40.36 per USD in March 2008 to Rs.51.23 per USD in March 2009, reflecting at 21.2 per cent depreciation during the fiscal 2008-09. However, now it is recovered and hovering around Rs.46.00.

Money Market: The money market consists of credit market, debt market and government securities market. All these markets are in some or other way related to the soundness of banking system as they are regulated by the Reserve Bank of India. NPAs of banks may indeed rise due to slowdown but given the strength of the banks balance sheets, that rise is not likely to pose any systemic risks.

Stock Market: Indian stock market crashed from the high of 20000 to a low of around 8000 points during the year 2008-2009. Corporate performance of most of the companies remained subdued, and the impact of moderation in demand was visible in the substantial deceleration during the said years. Corporate profitability also exhibited negative growth, which has led to the bearish trend in the stock market. Recession has effected the investments made by Foreign Institutional Investors (FIIs) in the Indian Stock Market as FIIs started disinvesting to meet their commitments abroad. This is putting lot of pressure on domestic financial system, which has led to liquidity crunch in all major sectors of the country.